Sunday, 22 November 2015

Stigliz on Coase

In his book Whither Socialism? Joseph Stigliz writes,

Coase went wrong in assuming that there are no transaction costs and no information costs. But the central contention of this book is that information costs (what can be viewed as a special form of transaction costs) are pervasive. Assuming away information costs in an analysis of economic behavior and organization is like leaving Hamlet out of the play.

But as is obvious to anyone who as read Coase the last thing he did was to ignore transactions costs. In fact the opposite is true, Coase's whole framework is based on the very notion of positive transaction costs. To quote Coase,

The world of zero transaction costs has often been described as a Coaseian world. Nothing could be further from the truth.It is the world of modern economic theory, one which I was hoping to persuade economists to leave.

For example, within a Coaseian framework the firm only makes sense in a positive transaction cost setting, if transactions costs are zero then production can take place via market transactions, with no firms needed. As Nicolai Foss has noted,

With perfect and costless contracting [due to zero transaction costs], it is hard to see room for anything resembling firms (even one-person firms), since consumers could contract directly with owners of factor services and wouldn't need the services of the intermediaries known as firms.

When thinking about the law and the actions of the courts Coase made the point that when the courts assign rights and liabilities in a context of zero transaction costs their decision does not matter. If an inefficient allocation of rights is made then the parties can bargain to an efficient one. But if transaction costs as are positive, as Coase stressed they are, then there is no inherent tendency for a welfare-maximising result to emerge, since the existence of these costs may block potentially mutually beneficial exchanges between the parties. In such a case the court's decision does matter.

When it comes to a Coaseian approach to policy Mark Pennington has noted,

[ ... ] the purpose of Coase’s analysis was to highlight the policy implications that flow from recognising the significance of transaction costs. Imperfections or frictions in markets may result in less than optimal outcomes – but these imperfections or frictions exist under any institutional alternative which involves direct government intervention. Deciding whether to rely on one mechanism or another requires a comparative institutions approach which considers the extent of the likely transaction costs under different types of ‘solution’.

So again positive transaction costs are central to the argument.

Stiglits's view show a profound misunderstanding of Coase's work. But it is a misunderstanding that is all too common.